The Gordian nightmare of public pensions

By Felix Salmon
December 27, 2010

Maybe it’s because I’m European, but I simply cannot get my head around a developed nation where people with lifelong service in the police or the fire brigade can find themselves with no pension at all. Zero. But if you’re unlucky enough to have served in Prichard, Alabama, that’s the situation you’ve found yourself in for the past 14 months

The NYT had a heart-rending story on the city’s finances last week: it seems that if a city has unfavorable demographics and an incompetent government, then there’s no one—not the state, not the federal government, not any kind of pensions guarantee agency—willing to step in and make things right.

Nettie Banks, 68, a retired Prichard police and fire dispatcher, has filed for bankruptcy. Alfred Arnold, a 66-year-old retired fire captain, has gone back to work as a shopping mall security guard to try to keep his house. Eddie Ragland, 59, a retired police captain, accepted help from colleagues, bake sales and collection jars after he was shot by a robber, leaving him badly wounded and unable to get to his new job as a police officer at the regional airport.

Far worse was the retired fire marshal who died in June. Like many of the others, he was too young to collect Social Security. “When they found him, he had no electricity and no running water in his house,” said David Anders, 58, a retired district fire chief. “He was a proud enough man that he wouldn’t accept help.”

Back in March, Prichard was given two months to work out how it was going to pay its pensioners—and that was after they’d already gone without pay for half a year. Today, we’re told, “a mediation effort is expected to begin soon.” And according to Michael Corkery, the city has proposed capping benefits to current retirees at about $200 a month.

The problem here isn’t gold-plated pensions—Prichard was paying out only $1,000 a month on its average pension when it defaulted back in October 2009. Neither is it, as Mish would have it, the Alabama legislature, which passed various bills amending city pension plans over the years. And it’s not greedy bondholders, either, asserting their seniority over pensioners: Prichard doesn’t have any outstanding bonds, and even bank loans don’t seem to be an issue.

Ultimately, the problem here is a confluence of two factors. On the one hand you have the nationwide—and indeed global—issue of unfunded public pension liabilities. On the other hand you have the statistical inevitability that in a country with thousands of municipal pension plans, some of them are going to run out of money.

One thing I’m pretty sure about: if and when a city with bonded debt arrives at the same place as Prichard, all the covenants in the world won’t be enough to protect bondholders from default. It’s politically impossible to pay creditors on Wall Street while short-changing people who worked for the city for decades and who have no other income to fall back on.

And more generally, the problem of municipal pensions is shaping up to be a Gordian nightmare. Cities which have diligently funded their own pension plans won’t ever want to bail out those who haven’t, or see federal funds used for such purposes. But on the other hand, situations like Prichard’s are clearly unacceptable, which means that there has to be some kind of bailout. Public pensions, I fear, could turn out to be the biggest moral-hazard play ever.

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Comments
29 comments so far

I was confused when I read your writeup of this last week, as the NY Times seemed to suggest that the government could somehow “penalize” Pritchard (via higher taxation) into solving this problem. The problem is simple: the money isn’t there to meet the promises. All the threats, laws, or penalties in the world can’t solve that problem

But the real problem is that we CONTINUE to let pension funds use aggressive return assumptions – like 8.5% annualized – which virtually guarantees that other municipalities will be underfunded and face the same issues.

Posted by KidDynamite | Report as abusive

There is nothing wrong with expecting healthy 58 year old people to work. If they cannot work there is disability. The retired fire marshal didn’t have to die without water and lights, even without resorting to private charity.

Posted by OneEyedMan | Report as abusive

Pensions have been inflated away or defaulted upon many times in the past. I wouldn’t be surprised to see that the creditors make out better. If you need to keep borrowing money for expenses and infrastructure you are going to have a lot of trouble telling bond holders that you decided to pay pensions instead.

Posted by OneEyedMan | Report as abusive

KidDynamite, you are letting facts blind you to the moral outrage.

OneEyedMan, I suspect there are not a huge batch of choices for someone of his age with his work experience. I am also sympathetic to someone who has worked for many years only to find out his employer has defaulted on their obligations. I have to say I find it a bit strange that he was so determined to not take any help whatsoever that he died in the dark with no water.

Posted by Danny_Black | Report as abusive

I agree he didn’t have a lot of good choices. But his employer didn’t buy any pension insurance, so to bail him out now would mean the rest of us would have to take care of him so he doesn’t have to work a lousy job. That isn’t our responsibility, certainly not if he is able bodied and just doesn’t like those jobs.

Posted by OneEyedMan | Report as abusive

I did notice in the article that Prichard enabled retirement in one’s fifties, even with minimal service, so it’s a bit better than basic.

I think the problem is that a large majority of American workers don’t have defined-benefit pensions, and there’s an underlying current of entitlement concerning such a benefit. That’s especially true considering government pensions, which are paid for largely by the the taxes of those without such pensions.

As for the moral hazard, my guess is that most American workers without pensions are happy not to pay taxes to fund public pensions. Not saying that’s right, but I’m guessing that if you ask people’s opinion, that’s about where it would fall.

Posted by Curmudgeon | Report as abusive

yes – defined benefit pension plans with overly aggressive assumptions ARE the problem. I worry that the problem hasn’t been remedied at all. For example, my sister is a teacher, as were both my parents. My sister contributes more to her pension than my parents did during their careers, but it’s still not enough to make up the shortfall if/when the 8.5% annualized return numbers prove to be optimistic.

Posted by KidDynamite | Report as abusive

“It’s politically impossible to pay creditors on Wall Street while short-changing people who worked for the city for decades and who have no other income to fall back on.”
Good one. Are you here all week?

Posted by RZ0 | Report as abusive

I saw the Times article, and it seems strange to me to allude to these legislature-imposed changes to the agreement without even an illustrative example. Does Alabama mandate some minimal pension for certain classes of municipal employees? Does Alabama forbid pensions that don’t meet certain standards — such that, by virtue of having a pension, Prichard had to meet those standards? Felix, if you could manage to report where the Times failed, I for one would be happy to have more information. (My own attempts at web searches haven’t provided anything.)

Posted by dWj | Report as abusive

PRICHARD, Ala. (May 19, 2010) – The Prichard Housing Authority is celebrating the grand opening of its new Administration Building… The $2.9 million dollar building was constructed by Case Construction of Mobile…”

http://www.thecityofprichard.org/pdf/PHA %20Grand%20Opening.pdf

Posted by AndrewDover | Report as abusive

Teachers here now contribute 11% to their pensions, funding more than half of the cost from their own pocket. I fear, however, that the system is being drained by the previous generation that contributed just 5%. How much will be left in 20 years for those who were hired in 1995? And will the public be willing to pay for the shortfall through higher taxes?

I see defined-benefit systems as a trap. I’ve known many teachers who hung on for five years too long because they could not afford the reduced pension from retiring early. Other teachers have left teaching (or at least the public schools) while they still enjoyed the job because there is no financial incentive to continue teaching once you have reached the maximum pension benefit. (The pension contributions and payroll taxes eat up almost all the difference between the salary and the 80% pension.)

A defined-contribution system is infinitely more fair. You get out of the system what you put in, plus an agreed-upon employer contribution. No way to game the system, no lopsided incentives to stay too long or leave too early. Moreover, the retiree can implement his own payout schedule — of great value to somebody dealing with cancer in their 60s.

The counter-argument is that people are too stupid to run their own lives, and thus we need to do it for them. I find that a poor excuse for infringing on people’s freedoms.

Posted by TFF | Report as abusive

By the way, I have nothing against generous pension schemes. I simply prefer the defined-contribution model. Some universities match a 3% employee contribution with a 9% employer contribution. That is even more generous than the teacher pension system (11% employee contribution, 80% pension after 30-35 years).

If you feel that is too much, then reduce the employer match. But at least put the facts out in the open, in a form that anybody can easily interpret.

Posted by TFF | Report as abusive

It shows again the foly of depending on govrnment to take care of us. Much better to have a defined contribution plan and own your retirement assests instead of relying on a government promise to pay.

Posted by DennisAOK | Report as abusive

@TFF – Employer match? What’s that? None of my 10 or so employers have ever had anything like that.

Posted by Curmudgeon | Report as abusive

@TFF – I’m curious as to what you mean by “funding more than half of the cost from their own pocket”… I think the entire problem with defined benefit plans is that we don’t know the costs until the end when it’s too late.

Posted by KidDynamite | Report as abusive

@DennisAOK, I absolutely agree. I fear we are approaching a time when wide swaths of our economy will be upended. At least there is hope of holding on to some portion of the assets if I can invest them myself rather than relying on a corrupt/incompetent pension manager to fulfill promises that were never fully funded in the first place.

@Curmudgeon, I’ve never had a match myself. Simply acknowledging that there is a range of possibilities, depending on how generous you wish to make the plan. A 3/9 plan is approximately as generous as the historical teacher’s pension. Newly hired teachers pay almost the full cost of their pension (assuming that 8.5% annual return, which I admit is a bit unrealistic).

@KidDynamite, while I was still in the system I ran the calculations using the salary ladder of my school, an assumption of 3% annual raises (at the time that was considered roughly the long-term inflation rate), and a variety of return assumptions between 8% and 12%. An 80% pension after 35 years (assume age 60 at retirement) is roughly what you would expect from a 12% annual contribution with an investment return of 8.5% based on commercial annuity rates. There is definitely some value to having a guaranteed return that large, however even with more pessimistic assumptions the teacher (myself) was funding the majority of the pension. And that is without even considering the Social Security clawback provision.

I don’t trust that “guaranteed return” anyways. One way or another, the “promise” will be broken (or modified). Possibilities:
(1) Long-term inflation outpacing wages over the next 20 years. Since the pension is based on the final salaries, anything that holds down the salary scale will serve to hold down pensions.

(2) Persistent inflation eroding the value of the pension after it locks in. An 80% pension sounds great, a 40% pension less so. (Replacing Social Security.)

(3) Pension systems across the nation declare bankruptcy, dumping the obligations on the federal government. In the process the pensions get reset to a fraction of their promised value.

Posted by TFF | Report as abusive

Why should fireman and policeman get pensions? They should get a competitive wage but they are already getting WAY more than that. Fireman deserve to get paid but there are many volunteer firefighting crews out there doing it for FREE.

Why doesn’t the government just guarantee everyone a pension (note: not actually suggesting this I’m being sarcastic)? Why do govt employees deserve a pension any more than the rest of us? They are already getting paid 20% more BEFORE their absurd benefits.

http://www.usatoday.com/news/nation/2010 -03-04-federal-pay_N.htm

Posted by McMath | Report as abusive

Provide everybody a pension? What a wonderful idea! We can start by taking 12% of all wage income. After all, a 12% contribution if properly invested ought to provide a pretty decent pension.

But get this! Instead of investing the money in the financial markets (risky!), we’ll simply use it for other purposes. That’s okay, we’ll promise to provide benefits when you retire. Can always fund that through borrowing. But an 80% pension? Too much. We’ll aim to replace 40% of your income.

What should we call this new pension plan? “Old Age Insurance”, perhaps?

Posted by TFF | Report as abusive

Mish’s harsh view of public pensions is based almost entirely on his experience in Chicago/Illinois, where he lives. He should get out more.

Posted by maynardGkeynes | Report as abusive

It’s a fairy tale to think people will give you substantial amounts of money when you add no value.

The days of paid retirement are ending. People in our generation will work as long as we’re physically able, and hopefully there will be still some remnant of Social Security left to cover us in our final months, when we’ve grown too frail to go on.

Posted by RobSterling | Report as abusive

McMath, am sure if your house was burning down with you in it you’d be glad these overpaid professionals are there as opposed to amateurs doing it when they feel like it.

Posted by Danny_Black | Report as abusive

Great thread with many good points already…

The one point I wanted to respond to was TFF who said “The counter-argument is that people are too stupid to run their own lives, and thus we need to do it for them. I find that a poor excuse for infringing on people’s freedoms.”

I too loath anything that chips away at my personal freedom… my issue with that thinking is that the “stupid” defined as those who have not and will not adaquatly plan for their retirement, currently outnumber the prudent by a margin of perhaps 4-1.

Remember that ALL are welcome in the voting booth… so don’t be supprised when IRAs, 401ks, & unearned income face a special tax to help offset the cost of supporting the vast majority of the population who don’t like the idea of starving to death alone in the dark.

P.S. to Danny black… the amateurs in the three small towns surrounding my town are often called in to help our pro’s during really large fires. They train as much as our national guard forces. I’m not sure they are representitive of vol departments everywhere but I’m impressed with our locals.

Posted by y2kurtus | Report as abusive

y2kurtus, sorry wasn’t meant to disparage the volunteers, rather to pour some cold water on the idea that firefighters deserve a pay cut because some people are brave and kind enough to do it on a voluntary basis, a view that I suspect the original poster would be closer to if he was sitting in a burning house.

Posted by Danny_Black | Report as abusive

Good points, y2kurtus.

I suspect having volunteer fire fighters works better in smaller communities where there is less of a temptation to “let somebody else do it”. But yes, they train very hard for that role. Response times might be a little slower, since you have fewer people standing by at any time, but that isn’t a knock on their professionalism.

Posted by TFF | Report as abusive

The US has a total tax income to GDP of around 28%.
Australia has a total tax income to GDP of around 31%.
All Australians are covered by a comprehensive means tested social security system and universal health care.
http://en.wikipedia.org/wiki/Social_Secu rity_(Australia)
http://en.wikipedia.org/wiki/Medicare_(A ustralia)
Generally the only homeless people in Australia are people with mental health issues, drug addicts or teenagers escaping abuse.
Do some people cheat the system to get out of working? You better believe it. But a lot of these people would turn to crime to survive if the pensions didn’t exist. A pension costs the government a lot less than keeping someone in jail.
I was totally astounded at the number of homeless people when I visited L.A. fifteen years ago.
I’m not sure how the architects of the US system managed to turn the US working class against all socialist ideas in a Christian country but they sure did a thorough job.
I’m very thankful I live in a country whose citizens believe in helping your fellow man when they need help.

Posted by RandomName2nd | Report as abusive

No appoligies neccessary EVER Danny Black… I always enjoy reading your comments along with almost all the other “regulars” on Felix’s blog.

I didn’t take your post as a slight to the volunteers in the first place. In Maine you could make a strong case for most citys and towns to have a volunteer force of fire and rescue. I’d like to see more towns drop their local police force and contract those services through the county sheriffs office as well.

My town has a miniscule crime rate… and the police are advocating to include a 1.5 million dollar firing range in the new police station. They currently rent out a local private gun club 4 times a year for $1000/day.

I’m all for improving public safety… accept when the payback on investment is 375 years.

Posted by y2kurtus | Report as abusive

Felix I think it is because your European, Americans see nothing wrong in working their parents to death, it’s the American way.

Posted by Sinbad1 | Report as abusive

I am an American, a lifelong NYC resident and a son of a NYC Police Officer. I work in the private sector and do not have a defined benefits plan.

In looking at the pension situation, there is one very simple cause – unmitigated greed by the Public Sector Unions.

My father worked 30 years and receives a $35k annual pension. Yet he was still able to retire at 55. A reasonable pension.

Today, we have public sector workers retiring at the age of 40 with $100,000+ annual pensions. A person is entitled to a reasonable pension – one that would be matched by private investment without any subsequent taxpayer funding. The Democrats and Unions have FOUGHT any true accounting for pensions and medical benefits in the Public Sector, while passing ever more constraining legislation for the Private Sector. A true accounting would reveal the Ponzi / Madoff scheme that we now have.

We are now at the precipice. Public Sector pensions as we have them today are unsustainable! In fact, looking at the U.S. census we see a decline in population in those states which were the most “generous” in Public Sector pay and benefits. Why? They taxpayer is being bled to death to support these $100,000 annual pensions for men and women who retire at the age of 40!

I as a taxpayer will NOT pay more taxes to pay for bloated pensions. I will move out of State or even the U.S. Or, I will simply stop working and subscrbe to the NEW American Dream – default on my debt and collect unemployment for 3 years.

The solution? Cap ALL taxpayer funded pensions at $50K, increase retirement age to 62 and eliminate defined d=benefits plans for the Public Sector. I would even eliminate the right for Public Sector workers to Unionize.

The alternative – many, many more Pritchard’s.

Posted by GreatKills | Report as abusive

“It’s politically impossible to pay creditors on Wall Street while short-changing people who worked for the city for decades and who have no other income to fall back on.”
___________________

Many of those “creditors on Wall Street” are pension funds or other retirees on fixed income. Who makes the decision as to which retirees are more deserving to keep their retirement income? Robbing Peter to pay Paul?

Posted by anonym0us | Report as abusive
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